Is Your Company Looking For Investors?

We have set out below a summary of a few of the issues which must be considered before embarking on a fundraising exercise.

In order to encourage potential investors to invest in your company, you will need to provide them with information about your business, its trading activities and its assets and liabilities. To do this, you will probably need to prepare some form of business plan or investment memorandum. At the very least, you will need to explain your business to them by telephone or in a face-to-face meeting.

These activities are likely to constitute "financial promotion" under the UK Financial Services and Markets Act 2000 (‘FSMA’). The term "financial promotion" is usually taken to mean an invitation or inducement to engage in investment activity.

By giving the business plan to various people, you will almost certainly commit an offence under FSMA unless the company itself is an "authorised person", as defined in FSMA (usually an investment bank, broker or financial adviser) or the content of the business plan has been formally approved by an authorised person. This rule applies not only to statements made in the business plan itself, but also to verbal statements (i.e. by telephone or in meetings) which are likely to lead to the recipient investing in the company. Indeed, stricter rules apply to these so-called "real-time" communications unless the recipient is an investment professional, can reasonably be expected to understand the risks or has requested the verbal or other communication. To be on the safe side, unless the company is confident that the recipient is an investment professional, it would be best to write to the recipient and suggest a telephone call or meeting, rather than cold-calling them.

The rule prohibiting financial promotions is subject to various exemptions, which are discussed below.

If the company contravenes these provisions of FSMA, it and its directors could be fined and the company may be unable to enforce any agreement to invest in the company which results from the financial promotion or marketing of the investment.

First, you should only give your business plan to recipients in the UK. If you are planning to extend a fundraising offer to non-UK recipients, you will have to comply with the applicable overseas regulations. We can arrange foreign legal advice through our international associate firms.

Secondly, if the company is an authorised person or the business plan or the communication has been approved by an authorised person then the business plan can be issued to a wide variety of potential investors, subject to various other guidelines.

Assuming that the company is not an authorised person, then there are various exemptions to the prohibition on financial promotion contained in FSMA. For example, the business plan will not require approval by an authorised person if the only recipients are:

(a) investment professionals;

(b) high net-worth individuals or companies; or

(c) sophisticated investors.

An "investment professional" is usually taken to mean a person or organisation specifically authorised or exempted under FSMA or whose business routinely involves dealing in, or advising on investments. This would include stockbrokers, banks, corporate finance houses and, in many cases, accountants.

High net-worth individuals, companies and unincorporated associations are those with assets of a value above certain thresholds which, in effect, enable them to face the risks involved in making a proposed investment.

To qualify as a high net-worth individual, a person must comply with the following guidelines:

1. there must be a signed statement by the individual, made no more than 12 months before the investment communication is made, stating that the individual believes he or she is a ‘high net worth individual’ and may receive unapproved communications; and

2. the certificate must be accompanied by a certificate from the individual’s accountant or employer, made within the last 12 months, which states that, in the opinion of the person attesting to the certificate, the individual has either (a) received an annual income of not less than £100,000 during the financial year immediately preceding the date of the certificate; or (b) held net assets to the value of not less than £250,000 throughout that financial year. These financial thresholds may well be increased in the future.

Many people would automatically assume that they qualify as certified high net worth individuals on the basis of the value of their homes. However, FSMA provides that an individual’s net assets do not include their main residence, pension or life insurance. The exemption for high net-worth individuals is also limited to certain types of investment.

The communication to the high net-worth individual must indicate (a) that it is exempt on the ground that it is made to a high net-worth individual (b) the requirements for qualifying as a high net-worth individual (c) that the content has not been approved by an authorised person – and will not therefore have been subject to the tests and controls which would have been imposed if it had been approved (d) that the investment may expose the individual to significant risk of losing their investment and (e) that if in doubt, the individual should contact an authorised person.

A high net-worth company is one with at least 20 members plus share capital or net assets of at least £500,000 or, alternatively, with less than 20 members but with share capital or net assets of at least £5 million. A high net-worth unincorporated association is any unincorporated association or partnership with net assets of not less than £5million.

To qualify as a sophisticated investor, a person must have a certificate signed by an authorised person within the previous three years, confirming that the individual is sufficiently knowledgeable to understand the risks associated with the type of investment which is being offered.

In addition, the certified sophisticated investor must have made a statement within the last 12 months that he or she qualifies as a sophisticated investor and may receive unapproved communications in relation to specific categories of investments (and these must be listed in the statement).

The communication to the sophisticated investor must indicate (a) that it is exempt on the ground that it is made to a sophisticated investor (b) the requirements for qualifying as a sophisticated investor (c) that the content has not been approved by an authorised person (d) that the investment may expose the investor to significant risk of losing their investment or incurring additional liability and (e) that if in doubt, the investor should contact an authorised person.

Unlike the exemption for high net-worth individuals, the exemption for sophisticated investors is available for all types of investment.

The above exemptions are helpful, but any company seeking funding is still presented with the practical issue of how to find potential investors. There is no central register of investors who are exempt from FSMA. However, a number of authorised persons, including brokers, corporate finance houses and some accountants, have created networks of people to whom prospective investments may be offered without breaching the restrictions in FSMA. Indeed, the FSMA regime includes a specific exemption to permit the promotion of investment opportunities to networks of these so called "business angels".

When sending an "unapproved" business plan (i.e. one which has not been approved by an authorised person) to an exempt person described above, the company must ask them to keep it confidential, and not to pass it on to any other person. Otherwise, if the recipient passes it on to another person who is not in the same category, the company could be treated as having caused the business plan to be issued to that other person and thereby itself commit an offence under the FSMA regime.

Any financial promotion must also include a statement that it is only communicated to a specific class of exempt recipient, and that other types of recipient are not permitted to take up the investment and should return any document to the company. The company must also take other measures to ensure that the recipients of any financial promotion fall within the relevant class.

Many companies seeking investors will want to put their business plan on the company’s website. Using the internet to promote a fundraising exercise raises a number of issues, as there is a risk that the website will be accessed by a potential investor who does not fall into one of the categories of exempt persons described above. In addition, the internet can be accessed world-wide so, in theory, to be absolutely safe, the company would need to ensure that any communication on its website complied with the regulatory regimes applicable in every country in the world.

If the company wishes to use the internet, it must at least adopt the following approach:

• include a prominent disclaimer on the website making it clear that (a) the communications are "directed" to certain types of persons; (b) such persons must be resident in the UK only; (c) the investment is only available to such persons; and (c) that persons who do not fall within that category should not rely on the communication.

• establish proper systems and procedures to prevent other recipients from engaging in the investment activity – for example, only allowing access to the website to persons who have provided the certificates referred to above, together with appropriate information confirming their UK residency.

The guidance issued both before and after FSMA suggests that this approach would reduce the likelihood of the FSA taking action for breach of the legislation. Ultimately, however, there is no guarantee that any disclaimer or other measure will be effective, so the safest course would be to avoid using the internet to promote a fundraising exercise.

If a private company is offering its shares to the public (usually taken to mean more than 5-10 people), it should re-register as a plc. To reregister, the company must have, amongst other things, issued share capital of at least £50,000, of which at least one-quarter is paid up.

Under the Public Offers of Securities Regulations 1995, subject to certain limited exceptions, the company must publish a prospectus if it is offering its shares to more than 50 persons. The fifty-person limit refers to the number of people to whom the investment is offered, not the number who actually take it up. For example if you offer an investment to 150 people, you will be required to issue a prospectus, even if only 25 people take up the investment.

A prospectus is a document which describes the company and its business and must contain all the information an investor might reasonably need to make an informed investment decision. Preparing a prospectus is a complex and timeconsuming and can be costly. Professional input at an early stage is highly recommended.

The directors of the company may be personally liable to anyone who suffers loss as a result of an incorrect or misleading statement in a prospectus.

In addition, under section 397 FSMA, a director will commit a criminal offence if, in connection with inducing a person to acquire shares, he (a) makes a statement, promise or forecast that he knows is misleading, false or deceptive; (b) dishonestly conceals any material facts; or (c) recklessly makes (dishonestly or otherwise) a statement, promise or forecast that is misleading, false or deceptive.

It is also a criminal offence under section 397 of FSMA to carry out any act or engage in any course of conduct that creates a false or misleading impression as to the market in, or value of, any shares, if it is done for the purpose of creating that impression and inducing the acquisition of the shares.

The above is a brief summary of a complex set of different statutes and statutory instruments. We recommend that you adopt the following procedure:

1. Consult us at an early stage, and keep us informed on an ongoing basis so we can advise you on what you can and cannot do.

2. Before sending a business plan to any prospective investor or intermediary, send that person a confidentiality letter - including a restriction preventing them from passing the business plan on to any third party - and ask them to sign and return the letter to you.

3. Check the business plan carefully to ensure that each statement in it is accurate, supportable and not misleading.

4. When speaking to potential investors or intermediaries about the business plan or any aspect of the company’s business, avoid making any statements which are inconsistent with the business plan or which are inaccurate, unsupportable or misleading - either in themselves or in the context of the offer as a whole. Remember that the rules set out above also apply to verbal statements.

5. Approve the business plan at a full meeting of the company’s board of directors before sending it to potential investors.

6. Keep a complete record of the persons to whom you send the business plan, and the date, and mark each copy with its individual number before you send it out.

You may wish to consider other forms of funding, either as well as, or instead of raising it from third party investors. For example, you could approach the existing shareholders in the company, if appropriate, and ask them to subscribe for additional shares. Alternatively, you could consider raising funds by means of bank loans, asset finance or equipment leasing.

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